part 3 powerpoint presentation by charlie cook copyright © 2003south-western college publishing....

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PowerPoint Presentation by Charlie CookPowerPoint Presentation by Charlie Cook

Copyright Copyright © © 2003South-Western College Publishing.2003South-Western College Publishing. All rights reserved.All rights reserved.

Startups and Startups and BuyoutsBuyouts

55

Pursuing New Venture Opportunities

12e

Copyright © by South-Western College Publishing. All rights reserved. 5–2

Looking AheadLooking AheadLooking AheadLooking Ahead

After studying this chapter, you should be able to:

1. Identify five factors that determine whether an idea is a good investment opportunity.

2. Give three reasons for starting a new business rather than buying an existing firm or acquiring a franchise.

3. Distinguish among the different types and sources of startup ideas.

4. List some reasons for buying an existing business.

5. Summarize four basic approaches for determining a fair value for a business.

6. Describe the characteristics of highly successful startups.


Identifying and EvaluatingIdentifying and EvaluatingInvestment OpportunitiesInvestment Opportunities

Identifying and EvaluatingIdentifying and EvaluatingInvestment OpportunitiesInvestment Opportunities

• “Startups with products that do not serve clear and important needs cannot expect to be ‘discovered’ by enough customers to make a difference.”—Amar Bhide–Infatuation with an idea may lead to an

underestimation of the difficulty of developing market receptivity and building a firm to capture the opportunity.


Is an Idea a Good Investment Opportunity?Is an Idea a Good Investment Opportunity?Is an Idea a Good Investment Opportunity?Is an Idea a Good Investment Opportunity?

• Is there a clearly defined market need for the product or service, and is the timing right?

• Can the proposed business achieve a durable or sustainable competitive advantage?

• Is the venture financially rewarding, and does it have significant profit and growth potential?

• Is there a good fit between the entrepreneur and the opportunity?

• Is there a fatal flaw in the venture that could make the business unsuccessful?


Two Paths to EntrepreneurshipTwo Paths to EntrepreneurshipTwo Paths to EntrepreneurshipTwo Paths to Entrepreneurship

Startup Startup CreatingCreating

a new a new business business

from from scratchscratch

BuyoutBuyoutPurchasing Purchasing an existing an existing businessbusiness


Reasons for Starting a New BusinessReasons for Starting a New BusinessReasons for Starting a New BusinessReasons for Starting a New Business

Developing a commercial market for a recently Developing a commercial market for a recently invented or newly developed product or service.invented or newly developed product or service.

Developing a commercial market for a recently Developing a commercial market for a recently invented or newly developed product or service.invented or newly developed product or service.

Taking advantage of available resources, ideal Taking advantage of available resources, ideal location, advances in equipment, employees, location, advances in equipment, employees,

suppliers, and bankerssuppliers, and bankers

Taking advantage of available resources, ideal Taking advantage of available resources, ideal location, advances in equipment, employees, location, advances in equipment, employees,

suppliers, and bankerssuppliers, and bankers

Avoiding precedents, policies, procedures, and Avoiding precedents, policies, procedures, and legal commitments of existing firmslegal commitments of existing firms

Avoiding precedents, policies, procedures, and Avoiding precedents, policies, procedures, and legal commitments of existing firmslegal commitments of existing firms


Evaluation Criteria for a StartupEvaluation Criteria for a StartupEvaluation Criteria for a StartupEvaluation Criteria for a Startup

• Marketing Factors–Need for product

Identified or unfocused

–CustomersReachable or not, brand loyal

–Value created for customerSignificant or insignificant

–Life of productRecovery of cost by customer



• Marketing Factors (cont’d)–Market structure

Emerging or matureMarket size (known or unknown?)Market growth (how fast?)

• Competitive Advantage–Cost structure

Degree of control over: price, costs, channels of supply

Barriers to entry: regulatory protection, response/lead-time advantage, legal, contacts and networks



• Economics–Return on investment?

Investment requirementsBreak-even point

• Management Capability–Diverse skills or solo entrepreneur

with no related experience

• Fatal Flaws


Basic Questions about StartupsBasic Questions about StartupsBasic Questions about StartupsBasic Questions about Startups

• What are the different types of startups you might consider?

• What are some sources for new ideas?• How can you identify a genuine opportunity that

creates value, for both the company and the company’s owners?

• How should you refine your idea?• What might you do to increase your chances

that the business will be successful?


Kinds of Startup IdeasKinds of Startup IdeasKinds of Startup IdeasKinds of Startup Ideas

• Type A–Startup ideas centered around providing

customers with an existing product not available in their market

• Type B–Startup ideas, involving new ideas, involving new

technology, centered around providing customers with a new product

• Type C–Startup ideas centered around providing

customers with an improved product

Copyright © by South-Western College Publishing. All rights reserved. 5–12Fig. 5.1

Example:Targeting the "New Age" beverage market by selling soft drinks with nutritional value

New Market

Type A Ideas

Example:Using high-tech computers to develop a simulated helicopter ride

Type B Ideas

New Technology

Example:Developing a personal misting device to keep workers cool

Type C Ideas

New Benefit

Types of Ideas that Develop into StartupsTypes of Ideas that Develop into StartupsTypes of Ideas that Develop into StartupsTypes of Ideas that Develop into Startups

Copyright © by South-Western College Publishing. All rights reserved. 5–13Fig. 5-2

Family Business 6%Friends/Relatives

5%

Personal Interest/Hobby 16%

Suggestion 7%

Education/Courses 6%

Chance Happening 11%

Other 4%

Prior WorkExperience

45%

Sources of Startup IdeasSources of Startup IdeasSources of Startup IdeasSources of Startup Ideas

Source: Data developed and provided by the National Federation of Independent Business Foundation and sponsored by American Express Travel Related Services Company, Inc.


Reasons for Buying an Existing BusinessReasons for Buying an Existing BusinessReasons for Buying an Existing BusinessReasons for Buying an Existing Business

1. To reduce some of the uncertainties and unknowns that must be faced in starting a business from the ground up.

2. To acquire a business with ongoing operations and established relationships with customers and suppliers.

3. To obtain an established business at a price below what it would cost to start a new business.


Pros and Cons of Buying an Pros and Cons of Buying an Existing BusinessExisting Business

Pros and Cons of Buying an Pros and Cons of Buying an Existing BusinessExisting Business

• Pros– High chance of success– Less planning– Existing customers/

suppliers– Necessary equipment– Bargain price– Experienced employees– Existing business records

• Cons– Existing problems– Poor quality of current

employees– Poor business image– Modernization required– Purchase price based on

inaccurate data– Poor business location


Investigating and EvaluatingInvestigating and EvaluatingAvailable BusinessesAvailable Businesses

Investigating and EvaluatingInvestigating and EvaluatingAvailable BusinessesAvailable Businesses

• Due Diligence–The exercise of prudence, such as would be

expected of a reasonable person, in the careful evaluation of a business opportunity

• Relying on Professionals–Accountants–Attorneys–Other experienced business owners


Finding Out Why the Business Is For SaleFinding Out Why the Business Is For SaleFinding Out Why the Business Is For SaleFinding Out Why the Business Is For Sale

• Owner’s reasons for selling the business–Old age or illness–Desire to relocate in a different section of the

country–Decision to accept a position with another

company–Unprofitability of the business–Discontinuance of an exclusive sales franchise–Maturation of the industry and lack of growth

potential


Examining the Financial DataExamining the Financial DataExamining the Financial DataExamining the Financial Data

1. Review financial statements and tax returns for the past five years.

2. Recognize that financial data can be misleading.

1. Assets overvalued

2. Expenses overstated/understated

3. Income underreported

4. Unrecorded debts

3. Prepare adjusted adjusted statements to reflect the true state of the business.


Income Statement as Adjusted by Prospective BuyerIncome Statement as Adjusted by Prospective BuyerIncome Statement as Adjusted by Prospective BuyerIncome Statement as Adjusted by Prospective Buyer

AdjustedOriginal Required IncomeIncome Statement Adjustments Statement

Estimated sales $172,000 $172,000Cost of goods sold 84,240 84,240Gross profit $87,760 $87,760Operating expenses:

Rent $20,000………………….Rental agreement will $24,000expire in six months; rent is expected to increase 20%.

Salaries 19,860 19,860Telephone 990 990Advertising 11,285 11,285Utilities 2,580 2,580Insurance 1,200………………….Property is underinsured; 2,400

adequate coverage will double present cost.

Professional services 1,200 1,200

Credit card expense 1,860………………….Amount of credit card expense 460expense is unreasonably largelarge; approximately $1,400 ofthis amount should be classified as personal expense.

Miscellaneous 1,250 $60,225 1,250 $64,025Net income $27,535 $23,735

Fig. 5-3


Valuing the BusinessValuing the BusinessValuing the BusinessValuing the Business

• Asset-Based Valuation–Estimates the value of the firm’s assets; does not

reflect the value of the firm as a going concern.

• Market-Comparable Valuation–Considers the sale prices of comparable firms;

difficulty is in finding comparable firms.

• Cash-Flow-based Valuation–Compares the expected and required rates of

return on the amount of capital to be invested in the business.


Asset-Based ValuationAsset-Based ValuationAsset-Based ValuationAsset-Based Valuation

• Modified Book Value Technique–Historical value of firm’s assets is adjusted to

reflect current market values.

• Replacement Value Technique–Value of firm’s assets is adjusted to reflect current

costs to replace the assets.

• Liquidation Value Technique–Value of firm’s assets is adjusted

to reflect their value if the firm ceased operations and disposed of the assets.


Market-Comparable ValuationMarket-Comparable ValuationMarket-Comparable ValuationMarket-Comparable Valuation

• Earnings Multiple (Value-to-Earnings) Ratio–Ratio is determined by dividing the firm’s value by

its earnings.–Firm’s ratio is compared to representative ratios of

recently-sold similar firms.

Earnings

valueFirmmultipleEarnings

EarningsRatiovalueFirm


Suggested Risk Premium CategoriesSuggested Risk Premium CategoriesSuggested Risk Premium CategoriesSuggested Risk Premium Categories

1 Established businesses with a strong trade position that are well financed, have depth in management, have stable past earnings, and whose future is highly predictable.

6 10%

2 Established businesses in a more competitive industry that are well financed, have depth in management, have stable past earnings, and whose future is fairly predictable.

11 15%

3 Businesses in a highly competitive industry that require little capital to enter, have no management depth, and have a high element of risk, although past record may be good.

16 20%

4 Small businesses that depend on the special skill of one or two people or large established businesses that are highly cyclical in nature. In both cases, future earnings may be expected to deviate widely from projections.

21 25%

5 Small “one-person” business of a personal services nature, where the transferability of the income stream is in question.

26 30%

Risk PremiumDescriptionCategory


Fig. 5.4

Firm

Risk

High

Low

Low

Earnings Multiple

High

Earnings Multiple

Low Firm Value

High Firm Value

Firm

Growth

High

Low

High

Earnings Multiple

Low

Earnings Multiple

High Firm Value

Low Firm Value

Determinants of a Firm’s Earnings MultipleDeterminants of a Firm’s Earnings MultipleDeterminants of a Firm’s Earnings MultipleDeterminants of a Firm’s Earnings Multiple


Cash Flow-Based ValuationCash Flow-Based ValuationCash Flow-Based ValuationCash Flow-Based Valuation

1. Estimate the firm’s expected cash flows.

2. Compute the firm’s cost of capital—the investors’/owners’ required rate of return on investments in the firm.

3. Using the cost of capital, calculate the present value of the firm’s expected cash flows—the value of the firm.


Nonquantitative Factors in Nonquantitative Factors in Valuing a BusinessValuing a Business

Nonquantitative Factors in Nonquantitative Factors in Valuing a BusinessValuing a Business

• Competition• Market• Future Community

Development• Legal Commitments• Union Contracts• Buildings• Product Prices


Negotiating and Closing the DealNegotiating and Closing the DealNegotiating and Closing the DealNegotiating and Closing the Deal

• Terms of Purchase–Assets purchase or total entity–Indemnification clause–Payment in full or partial payments over time

• Closing the sale–Best handled by a third party

Bill of saleTax certificationsPayment-to-seller agreements

and guarantees


Characteristics of Successful High-Growth Characteristics of Successful High-Growth StartupsStartups

Characteristics of Successful High-Growth Characteristics of Successful High-Growth StartupsStartups

• Begin as a team effort• Are in service and manufacturing industries• Have competent founders who:

–have related experience.–have started other businesses.–share in ownership of business.

• Are somewhat better financed• Do not limit themselves to local markets

part 3 powerpoint presentation by charlie cook copyright © 2003south-western college publishing....

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new ideas

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new businessdeveloping

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existing product

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